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Abstract: Using cross-sectional data from the SCF and Tax Model, we show that entrepreneurial income risk has a significant inf luence on portfolio choice and asset prices. We find that households with high and variable business income hold less wealth in stocks than other similarly wealthy households, although they constitute a significant fraction of the stockholding population. Similarly for nonentrepreneurs, holding stock in the firm where one works reduces the portfolio share of other common stocks. Finally, we show that adding proprietary income to a linear asset pricing model improves its performance over a similar model that includes only wage income. IN CONSTRUCTING INVESTMENT PORTFOLIOS, it appears that many if not most households fail to behave in a manner consistent with simple economic theory. Even among relatively wealthy households, the share of financial assets held in different asset classes varies widely, and there is evidence that among those who hold common stock, there is often little diversification ~e.g., King and Leape ~1987!, Blume and Zeldes ~1994!!. We begin this paper with an empirical investigation into some of the risk factors and demographic variables that might explain these cross-sectional differences in portfolio composition. A number of previous studies focus on the level and variability of wage income growth as one of the largest sources of undiversifiable income risk. Here we present evidence that, for the subset of the population that has significant stockholdings, income from entrepreneurial ventures ~which we refer to as proprietary business income) represents a large source of undiversifiable risk that is more highly correlated with common stock returns. These findings motivate the investigation in the second part of the paper of a linear asset pricing model that incorporates proprietary income from pri

Abstract: We examine the magnitude and sources of difference between income for tax and financial reporting purposes using publicly available data from 1988 to 1998. We find evidence that the book-tax income spread has generally increased over time, but that a relatively small set of variables are able to explain this increase. We also find that these same variables explain a large percentage of the variation in the book-tax spread across firms. While neither supporting, nor disproving, the existence and growth in tax sheltering behavior, the results do suggest that financial statement-based measures of income have become less representative of firms' taxable income.

Abstract: For a wide class of infinitely lived agent models, Chamley has shown that the optimal capital income tax rate is zero in the long run. Lucas has argued that for the U.S. economy, there is a significant welfare gain from switching to this policy. This paper shows that for the Bewley class of models with incomplete insurance markets and borrowing constraints, the optimal tax rate on capital income is positive, even in the long run. Therefore, cutting the capital income tax to zero may well lead to welfare losses.